Pricing is a prudential risk that comes with complications

  • 3 December 2019

Last month, the UK’s Prudential Regulation Authority wrote a ‘Dear CEO’ letter to insurers in the general market. It set out the regulator’s priories for 2020, one of which was the current pricing review. The message was clear – pricing is a prudential risk now. And a close eye is being kept on how how insurers handle it.

This is interesting, for it shows that the pricing review is not just being seen through the lens of conduct risk. It points to the expected impact of the pricing review being material enough for it to be categorised as a risk to the financial health of general insurers.

That shouldn’t come as any surprise though. After all, if your pricing philosophy, strategy and systems for two of your key products is under close scrutiny, then of course there’s a distinct possibility that your financial health will be monitored.

Message to the Chief Risk Officer

The PRA is signalling to insurers that they really must take care when calibrating their response to the pricing review. That message should be picked up by the chief risk officer, whose map of material risks should now show retail pricing as a ‘dark and dangerous place’ in need of greater scrutiny.

And this will be something new for most firms. A quick survey of the 2018 annual reports of five leading insurers in the UK retail general market found that not one of them mentioned pricing as a material risk. Insurers can of course point to the super-complaint landing towards the end of that 2018 financial year. And there’s some validity in that argument, but not enough. The super-complaint was obviously on the cards from January 2018, when I wrote about it in this post. Those five insurers employ lots of risk management people who are just as able to spot these things as myself.

Are Insurers under-estimating the impact of the pricing review?

So what’s behind the PRA’s CEO letter? Does it point to a concern about insurers’ maps of material risk for 2019 continuing to under-estimate the impact of the pricing review? It looks like it.

Let’s think about this for a minute. You’ll recall the FCA’s October 2018 report on pricing practices in household insurance. Its executive summary ended with these words:

“Our goal is to ensure that general insurance markets deliver competitive and fair pricing outcomes for consumers. We will act as required to ensure this happens, including where appropriate, taking steps that may fundamentally change pricing practices.”

Those last few words sent a unambiguous signal to the market: do not under-estimate our response to the problems that this thematic review has uncovered.  Now bring in the PRA letter. It is signalling one of (or both of) two things. Firstly, insurers are still not acknowledging the scale of the problem their pricing practices have created. And/or secondly, the regulator really is about to impose fundamental changes in pricing practices. Either which way, it feels like a ‘wake up and prepare for the medicine’ message.

Three Dimensions to Pricing as a Material Risk

So how should insurers respond? Oddly enough, the one thing I think insurers should not do is rush to stick retail pricing onto their maps of material risk. That’s because the ethical issues associated with retail pricing amount to much more than just the margin issues detailed in the interim pricing review. Two other dimensions of retail pricing risk have to be incorporated.

The first that very definitely needs attending to is discrimination. The second is around fairness and the acquisition costs of household business. Insurers should be preparing for something significant from the regulator on both of these points during 2020. How are your preparations going then?

Pricing is a prudential risk with ethics at its heart. This will be something new to most insurers, and their risk management functions will find it more nuanced than what they’re more used to dealing with. It’s more like an ethical bundle than an ethical issue. Those insurers who think carefully about it will recognise its different dimensions and respond to them in a coordinated fashion.  

Pricing is a prudential risk with ethics at its heart. This makes it more nuanced than what many risk management functions could be use to

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And that will be exactly what the PRA will be looking out for during 2020 – that insurers have thought it through and responded accordingly. Their ire will be kept for those who adopt a ‘wait and see’ approach. I would go so far as to suspect that that could be judged a certification issue for a chief risk officer.  After all, what other prudential risks are handling in that way!